Top Mistakes Law Firms Make in Trust Accounting and How to Avoid Them
Introduction
Trust accounting is one of the most important duties of law firms, with client funds held securely in their hand and in check. Trust accounting mistakes have severe financial penalties of thousands of dollars, negative reputation, and disbarment. Despite its importance, many law firms are continuing to commit avoidable trust accounting mistakes. Here, we cite the most common mistakes and introduce real-life remedies to help law firms remain on track and honest.
Commingling of Client and Firm Funds
Failure:
Commingling client trust funds with the firm’s operating funds is an egregious legal and ethical error. Even minor commingling, such as leaving client money briefly in a firm account, has catastrophic legal consequences.
How to Avoid:
- Have completely separate trust and operating accounts.
- Educate all staff involved with trust funds in ethical standards.
- Use specific legal accounting computer programs to record transactions and preclude inadvertent commingling.
- Regularly audit accounts to ensure proper segregation of funds.\
Lack of Reconciliations Regularly
Fault:
Inaccurate or incomplete reconciliations of trust accounts will result in errors being unnoticed and finances are not dealt with suitably.
Preventative Measure:
- Perform monthly reconciliations of trust accounts correctly.
- Utilize computer accounting software containing automatic reconciliation functions.
- Utilize a specific member to perform reconciliations and obtain independent verification.
- Keep complete records for compliance purposes on all reconciliations and errors.
Inaccurate Record-Keeping
Fault
Inaccurate or incomplete books will prevent tracking of client money, and failure to comply and audit will occur.
Prevention:
- Maintain clear and comprehensive records of transactions like deposits, withdrawals, and transfers.
- Each client should have a separate ledger reconciled to bank statements maintained.
- All the trust account files should be placed in safe custody for the term they are to be kept.
- Computer record systems should be adopted to prevent misplaced documents.
Overdrawal of Client’s Trust Account
Selling more money than is held in a client’s trust account can lead to ethical breaches and potential legal action.
Prevention:
- Segregate client balances from the overall trust account balance.
- Implement strict approval procedures before withdrawal of funds.
- Develop automated reminders to notify firms when a client’s balance is low.
- Conduct regular in-house checks to ensure funds are being used correctly.
Failure to Correct Bank Errors in a Timely Manner
Overlooked bank mistakes, such as miss deposits or unauthorized withdrawals, may lead to monetary discrepancies and regulation issues.
How to Prevent:
- Regularly review bank statements every month.
- Correct and report immediately any discrepancy.
- Implement a double-check procedure where at least two employees verify trust account transactions.
- Implement a written procedure for correcting bank mistakes.
Mismanagement of Client Retainers
Error:
Lack of monitoring and management of retainers leads to accidental misappropriation of funds.
Prevention:
- Make all retainers paid into a trust account until earned.
- Remind clients that their retainer balance is low.
- Refresh retainer agreements from time to time to delineate the purpose of funds.
- Maintain accounts free of all retainer money transactions.
Internal Controls and Auditing Deficiency
Without strong internal controls, law firms are most likely to fall prey to financial mismanagement, fraud, and compliance failures.
How to Avoid
- Have strict internal policies and procedures for handling trust accounts.
- Conducts internal and external audits on a regular basis.
- Utilize distinct employees to conduct deposits, withdrawals, and reconciliations in an effort to prevent fraud.
- Have a whistleblower policy to encourage reporting of suspicious activity.
Disregard of Trust Accounting Rules and Laws
Failure to keep abreast of trust accounting laws and professional rules will result in non-compliance and legal repercussions.
How to Avoid:
- Review periodically state bar association trust accounting legislation and bulletins.
- Provide periodic education to staff and attorneys staff handling trust fund operations.
- Refer to legal accounting experts if necessary.
- Use compliance checklists to ensure compliance with current requisites for all transactions.
Late or Improper Client Disbursements
Error:
Tardy or erroneous disbursements can lead to client dissatisfaction and noncompliance.
How to Avoid:
- Make distinct procedures for processing and authenticating disbursements.
- Check all payee details prior to payment.
- Use automatic reminders for disbursement due date tracking.
- Have open communication with clients regarding their money.
Maintaining Manual Accounting Procedures
Flaw:
Dependence on old, manual procedures raises errors, inefficiencies, and noncompliance.
How to Avoid:
- Invest in reliable trust accounting software designed for law firms.
- Reconcile and report automatically to reduce scope of human error.
- Provide complete training to staff regarding new accounting technology.
- Regularly review and update financial management processes to ensure maximum efficiency.
Final Words
Trust accounting errors can have devastating financial, ethical, and legal consequences for law firms. Detection and rectification of such typical errors by law firms will make them compliant, build client trust, and maintain their reputation. Implementation of the latest technology, implementation of strong internal controls, and up-to-date knowledge about industry regulations are the secrets of ensuring effective trust accounting processes.
By proper management of trust accounts and avoiding such pitfalls, law firms can feel secure in ethical and legal integrity, assured that client money is safely held and disbursed properly at all times.